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October 23, 2013

Don’t Claim Social Security Before 70, Alicia Munnell Says

Munnell of Boston College argues that inadequate income replacement will sabotage early benefit claims

The correct age for retirement is hotly debated in the financial services industry—a recent ThinkAdvisor report cites industry sources putting the age at 65, 70 and even 80. Viewed subjectively, or on the basis of popular opinion, many different answers are possible.

But a new analysis by Alicia Munnell, director of the Center for Retirement Research at Boston College, argues that objectively speaking, 70 is the de facto retirement age — at least as far as maximizing Social Security benefits is concerned.

Despite today’s confusing array of benefit-claiming possibilities, the benefit structure resulting from claiming Social Security at age 70 makes sense as a benchmark for income adequacy given current longevity and retirement saving trends.

In fact, Munnell argues that maintaining the current structure without the official “full retirement age” (currently 65 or 66, depending on year of birth, and scheduled to move to 67) would serve to clarify Americans’ retirement choices.

That is because, first of all, the focus on 65, the age set when Social Security benefits were first paid in 1940, does not jibe with contemporary conditions in which men and women both live on average seven years longer than they did then.

Were we to keep the expected number of years in retirement constant, the retirement age in 2020 would be 72; a more liberal calculation that would evenly distribute longevity gains between added time for work and leisure implies a retirement age of 70.

The calculations grow in complexity when considering socioeconomic factors — for example, the fact that the wealthiest 5% live 25% longer than the bottom 5%, a discrepancy that is actually growing wider over time.

While such factors make it difficult to design a fair benefit structure, Munnell argues the most useful metric in evaluating Social Security is the so-called replacement rate — that is, looking at benefits as a percent of preretirement income.

The system currently offers actuarially fair benefits at whatever claiming age, meaning that the reduced income of the 62-year-old Social Security recipient and the enhanced benefits of the 70-year-old will work out to be equal on a lifetime income basis.

That said, replacement rates will range from roughly 50% of preretirement income for the 70-year-old to just under 32% for a 62-year-old claimant. But these numbers overstate the net benefit. Once we factor in Medicare premiums (which Social Security automatically deducts) and taxation of benefits up to 85%, the true net replacement income ranges (for someone retiring in 2030) from 43% of income for a 70-year-old to 24% of income for a 62-year-old.

The former provides “a solid base on which to add 401(k) savings and home equity for a secure retirement,” whereas “retiring at 62 will not be a reasonable option for those who have any ability to stay in the labor force,” Munnell argues, adding that the same is largely true for someone retiring at 65 given today’s low 401(k) balances.

While claiming benefits at age 70 makes sense, the official retirement date of 65 has become meaningless, she says. That age (or the new higher age) neither describes the first date one can claim benefits nor the age at which benefits become adequate.

While Munnell favors eliminating “full retirement age,” she is concerned, however, about raising that age and the consequent change in benefit structure. The impending change to age 67 will reduce lifetime benefits by 7%.

However, raising the official retirement age to 70 would reduce net benefits to the 30-percent range, which Munnell describes as inadequate for those claiming at age 70, and grossly inadequate for those claiming earlier.

For that reason, she suggests caution with regard to raising the retirement age. Because many Americans can’t change their retirement date, Munnell argues that changing the benefit formula is a preferable means of reducing expenditures.

Under today’s benefit structure, Munnell concludes that those in communication with pre-retirees should advise them to remain in the workforce longer and not claim Social Security benefits before age 70.

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